TAKAFUL hosted a sharing session to explain the nature and implications of MFRS 17 comes 1 January 2023. It presents a more comparable revenue recognition measures based on the tenure and coverage of insurance contracts. However, the reclassification would lead to immediate dents to accounting revenue and book value. That said, these are purely accounting treatments and do not affect the prospects of the group. Maintain OP and TP of RM4.25 based on our hypothetically adjusted FY23E BVPS.

Recognition is more reflective of timing. Effective 1 January 2023, the insurance industry will be adopting MFRS 17 (to replace MFRS 4) pertaining to insurance contracts. In essence, insurers (and takaful operators) will move away from a lumpy Day 1 recognition of revenue and will instead defer its contract revenues throughout the tenure of the contracts in adjustment to future cashflows.

At the same time, the new standard will call for a re-presentation of a company’s books to account for the newly introduced Contractual Service Margin (CSM), which will be the cumulation of all unearned profits into Takaful Contract Liabilities. Unearned profits from contracts issued prior to 2023 will then be reclassified from retained earnings to liabilities, to be amortised over time in accordance with the terms of their respective contracts.

Key impact. Corresponding to the changes in revenue recognition, TAKAFUL anticipates that net profits would be toned down by 15-20% based on current year readings. However, this is also to say that the lost sum would be recorded in the subsequent years in line with the term of the contracts’ coverage. Meanwhile, as the previous earnings from these contracts are to be retracted, the extraction from CSM is estimated to reduce 30-45% of present retained earnings into Takaful Contract liabilities. Note that there is no equivalent of CSM in the current MFRS 4 standard. Following the above, as equities are reducing at a larger quantum than earnings, ROE is thus expected to expand, closer towards c.25%.

Prospects unchanged as the matters above are purely accounting treatments and do not impact the fundamental business of the group. We still anticipate the group to be a sound beneficiary of the recovery of the economy where overall earned premiums should pick up. This should also be uplifted by more aggressive physical sales strategies. That said, a resurgence of claims could be expected as more activities will most likely lead to more incidences and claims. Pre-pandemic, claims incurred ratio could reach upwards to 40-50%, although we anticipate a more moderate increase for the time being at 36% (from 34% during movement control periods).

Post update, we leave no changes to our assumptions for now as the new standards have yet to be implemented.

Maintain OUTPERFORM and TP of RM4.25. Our TP is based on an unchanged 2.2x PBV (implying 0.5SD below mean) on a hypothetically adjusted FY23E BVPS of RM1.94 which captures the factors of -30% to retained earnings and - 15% to EPS in FY23E. The stock could have been sold down due to scepticism of the new accounting standards and possible earnings weakness arising from higher claims. We believe this presents a buying opportunity as the current adjustments above illustrate that its merits could have been underpriced. Additionally, valuation levels still linger below pre-Covid levels (3-4x PBV) which could suggest strong re-rating gains should sentiment revert as well.

Source: Kenanga Research - 9 Jun 2022